One of the most difficult industry to value is banking, given that they adhere to different rules compared to other companies. The tiered capital structure is common for banks to abide by, in order to ensure they maintain a sufficient level of cash for their customers. Emphasizing data points like book values, in addition to the return and cost of equity, is beneficial for determining FHN’s true value. Below I’ll take you through how to value FHN in a fairly effective and uncomplicated approach.
What Model Should You Use?
There are two facets to consider: regulation and type of assets. Financial firms operating in United States face strict financial regulation. In addition to this, banks usually do not possess substantial amounts of tangible assets on their books. As traditional valuation models put weight on inputs such as capex and depreciation, which is less meaningful for finacial firms, the Excess Return model places importance on forecasting stable earnings and book values.
Deriving FHN’s True Value
The central belief for Excess Returns is that equity value is how much the firm can earn, over and above its cost of equity, given the level of equity it has in the company at the moment. The returns in excess of cost of equity is called excess returns:
Excess Return Per Share = (Stable Return On Equity – Cost Of Equity) (Book Value Of Equity Per Share)
= (0.12% – 11%) x $14.97 = $0.13
We use this value to calculate the terminal value of the company, which is how much we expect the company to continue to earn every year, forever. This is a common component of discounted cash flow models:
Terminal Value Per Share = Excess Return Per Share / (Cost of Equity – Expected Growth Rate)
= $0.13 / (11% – 2.9%) = $1.63
These factors are combined to calculate the true value of FHN’s stock:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $14.97 + $1.63 = $16.6
This results in an intrinsic value of $16.6. Given FHN’s current share price of US$13.81, FHN is fairly priced by the market. Therefore, there’s a bit of a downside if you were to buy FHN today. Pricing is one part of the analysis of your potential investment in FHN. There are other important factors to keep in mind when assessing whether FHN is the right investment in your portfolio.
For banks, there are three key aspects you should look at:
- Financial health: Does it have a healthy balance sheet? Take a look at our free bank analysis with six simple checks on things like bad loans and customer deposits.
- Future earnings: What does the market think of FHN going forward? Our analyst growth expectation chart helps visualize FHN’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether FHN is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on FHN here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.